The Minimum Wage Debate: How it Affects Small Businesses
The current debate about raising the national minimum wage (or local city, state and county minimum wages) is important to small business people. As entrepreneurs, we always have to be concerned about any development that drives up our costs if it does not add equivalent or better benefits. In this article, we summarize the main arguments in favor and against a minimum wage hike and conclude that individual business circumstances are a key determinant of how you might view this debate.
A recent report by the Congressional Budget Office (CBO) estimates that a progressive increase in the federal minimum wage from the current $7.25 an hour to $10.10 per hour by 2016 would increase the wages of 16.1 million Americans, resulting in an additional $31 billion in business earnings (Note: about 3.3 million American workers were paid at or below the federal minimum wage of $7.25 an hour in 2013, according to the U.S. Bureau of Labor Statistics. That amounts to about 4 percent of the American workforce). At first, that sounds good, but at the same time, the CBO estimates that such a raise would lead to the loss of 500,000 low income jobs or a 0.3 percent decrease in total employment as small businesses are forced to lay off people to pay the extra wages.
These dueling figures represent winners and losers. They sum up the key elements of the debate about raising the minimum wage. On the one hand, people have more money to spend on products and services. On the other hand, small business costs get driven up and this can lead to significant unemployment.
Why a higher minimum wage might be good or bad for a small business owner is context dependent. Here are two possible scenarios, an extreme positive case and an extreme negative case:
Extreme relevant positive case:
On the positive side, suppose you are a family business in military surplus that caters to budget conscious customers interested in clothing and survival items under $100. You are reasonably profitable and efficient and have a business model that provides you with good margins. You almost never wind up in the red at the end of each week or month and often do very well. Family members are the only employees and shareholders in the business. In this case, a national, state or city minimum wage might be beneficial to you. This is because you are really paying yourselves from revenue that is more than covering your costs. This means more money in many of your target potential customers’ pockets, likely leading to more sales.
As an interesting sidebar on this case, you may recall from history that Henry Ford doubled his workers’ wages from $2.50 per day to $5.00 per day. He accomplished this virtually overnight when he brought out his Model T Ford in the early 20th century. His reason was simple. He wanted his working class employees to be able to afford his product and the Model T sold for $300 dollars. Ford also added the first care financing system to make them affordable to his workers. Ford intentionally created a highly cost-effective business and production model that allowed him to be very profitable at that price.
Henry Ford was proven right because he had found an untapped sweet spot in the transportation market by catering to the many lower income farmers and factory workers. Many became auto workers, while his competitors were serving the rich and the professional classes who represented a much smaller market. When the Great Depression hit, guess who continued to survive?
Extreme relevant negative case:
Here is a negative example. You are also in the surplus business or some other kind of retail industry, but you tend to cater to higher end customers who want military vehicles or other hardware that trends to sell for over $500. Your business is not very profitable or efficient, generating very low margins. Store operation is close to break-even, sometimes losing money. Many of your employees earn minimum wage. Those wages and other employment costs are an important part of your overall costs. This probably means you will suffer by a higher minimum wage or may even have to lay off a number of people or go out of business. Also, your customers will be unlikely to buy any more from you, since they are not minimum wage employees. Your extra costs of doing business might drive you over the edge.
For those interested in the extended arguments in favor and against the minimum wage, the following lists from the Wikipedia page on the Minimum Wage Debate may be of interest:
Arguments in Favor of Minimum Wage Laws
Supporters of the minimum wage claim it has these effects:
- Increases the standard of living for the poorest and most vulnerable class in society and raises average.
- Increases incentives to take jobs, as opposed to other methods of transferring income to the poor that are not tied to employment (such as food subsidies for the poor or welfare payments for the unemployed).
- Stimulates consumption, by putting more money in the hands of low-income people who spend their entire paychecks. Hence increases circulation of money through the economy.
- Encourages efficiency and automation of industry.
- Removes low paying jobs, forcing workers to train for, and move to, higher paying jobs.
- Increases technological development. Costly technology that increases business efficiency is more appealing as the price of labor increases.
- Increases the work ethic of those who earn very little, as employers demand more return from the higher cost of hiring these employees.
- Decreases the cost of government social welfare programs by increasing incomes for the lowest-paid.
- Encourages people to join the workforce rather than pursuing money through illegal means, e.g. selling illegal drugs
- One way it can increase employment: When wages are very low, a worker often has to work very long hours to earn enough to live on. If wages are increased, then the worker can afford to work fewer hours. This frees up employment for another person.
- Most of the lowest-wage jobs are in services such as cleaning, security and care work . It is difficult to outsource many of these direct service jobs to other areas or countries with lower-cost labor. Hence there is a weakness in the argument that higher wages would mean that jobs would be lost to lower-wage areas.[
- A minimum wage is arguably a simpler, more direct and less bureaucratic way to ensure the lowest paid have a decent income compared to methods such as tax credits.
Arguments Against Minimum Wage Laws
Opponents of the minimum wage claim it has these effects:
- As a labor market analogue of political-economic protectionism, it excludes low cost competitors from labor markets and hampers firms in reducing wage costs during trade downturns. This generates various industrial-economic inefficiencies.
- Hurts small business more than large business.
- Reduces quantity demanded of workers, either through a reduction in the number of hours worked by individuals, or through a reduction in the number of jobs.
- May cause price inflation as businesses try to compensate by raising the prices of the goods being sold.
- Benefits some workers at the expense of the poorest and least productive.
- Can result in the exclusion of certain groups (ethnic, gender etc.) from the labor force.
- Small firms with limited payroll budgets cannot offer their most valuable employees fair and attractive wages above unskilled workers paid the artificially high minimum, and see a rising hurdle-cost of adding workers.
- Is less effective than other methods (e.g. the Earned Income Tax Credit) at reducing poverty, and is more damaging to businesses than those other methods.
- Discourages further education among the poor by enticing people to enter the job market.
- Discriminates against, through pricing out, less qualified workers (including newcomers to the labor market, e.g. young workers) by keeping them from accumulating work experience and qualifications, hence potentially graduating to higher wages later.
- Slows growth in the creation of low-skilled jobs
- Results in jobs moving to other areas or countries which allow lower-cost labor.
- Results in higher long-term unemployment.
The bottom line is you need to take a look at your own specific situation to determine whether you like and want to support the idea or not.
Geoffrey Henny is a published author and small business entrepreneur. At present, he is also an adjunct professor of Economics at Cleary University. Geoff was a former Shell International Petroleum Executive and a “Systems Thinking” Consultant with special expertise in Scenario Building and Risk Management.